London School of Economics EOPP: Economic Organisation and Public Policy Programme LSE
EOPP: Economic Organisation and Public Policy Programme

Current EOPP Research:
Spatial Asset Pricing: A First Step

Andrea Prat (with François Ortalo-Magné, University of Wisconsin-Madison)

Abstract:

We explore the dual role of housing, as an investment vehicle and as access to a location. Our dynamic stochastic model has four classes of assets: a risk free bond, houses (in various locations), stocks, and human capital (with different productivity in different locations). Agents choose where they live and can invest in the financial market and in all real estate markets. Local rents are determined in equilibrium by the utility of the marginal residents, which in turn depends on city sizes, local labor productivities, and local shock-insulation parameters. The dividend of a house is a stochastic process that is determined endogenously by how local productivity shocks affect marginal residents. The model leads to a closed-form representation of: (i) The portfolio decisions of agents as a combination of an investment in a financial and real estate mutual fund and demand in local housing to hedge the endogenous rent risk; and (ii) The returns of financial and real estate assets in terms of the covariance matrix of dividend shocks and local productivity shocks.

Related Paper

Spatial Asset Pricing: A First Step